Have gas, must export

Have gas, must export

To some, Canada’s shale natural gas deposits represent a huge opportunity for the country to cash in on our resource windfall. But for investors seeking a strategy in the sector, the path forward is far from clear.

A glut of liquid natural gas in the market, costly drilling processes and environmental hurdles are placing a significant dampener on investor possibilities in oil companies with interests in shale.

“There’s too much gas in the market,” says Ernst & Young partner Lance Mortlock in Calgary. “Our clients talk about shutting gas wells and producing less … that’s reduced the price and because of that companies are making less money — or no money in them at all. So they are shutting them.”

Canada has significant shale oil opportunities in several regions, including Alberta, British Columbia and New Brunswick. However the process has significant critics who say extracting natural gas from shale could create huge environmental issues.

All of this has made for a questionable investing scenario, even though prices for natural gas have started to recover.

“There’s a lag between when action is taken in the market and when prices adjust,” Mr. Mortlock says. “But companies are carefully looking at the market before changing any investment decisions. That means there’s no guarantee we’ll see increases in drilling because of the increase in prices. Everyone is still very nervous.”

Though prices have rebounded to around US$3.70 per million British thermal units, a far cry from earlier this year when prices sank as low as US$1.91, the big opportunity remains for exporting it to countries like Japan, which is still reeling from its nuclear energy disaster and pays around US$17 mBtu. With the International Energy Agency forecasting a 17% global increase in natural gas demand by 2017 — and China’s annual consumption more than doubling in that period — there’s still a sense of optimism that Canadian shale gas producers will benefit in the long run.

Asian demand will lead a 17% global increase in gas demand by 2017 from 2011, the International Energy Agency forecast in June. China’s annual gas consumption will more than double to 273 billion cubic metres in the period, and will equal about 28% of the reserves identified on Alaska’s North Slope.

That’s significant because if Canadian natural energy companies with shale exposure are going to be successful in the long run, it’ll likely be due to export demands.

“We find LNG export to be the single largest component to gas demand growth in the next eight years,” he writes in a recent research note, adding that demand will likely be most significant toward the end of that period.

However, Mr. Brackett doesn’t think that will increase the price significantly for LNG.

“We find that the supply side is sufficient to meet demand through 2020 and beyond and thus don’t see demand growth pushing prices,” he added.

The other question facing the sector is the U.S., which has significant shale gas regions.

Currently 87% of natural gas imported into the U.S. comes from Canada, which accounts for 14% of all natural gas used. However, the U.S. Energy Information Agency says that as American production grows, only 1% of natural gas used will come from outside the country by 2035.

That means the opportunity rests in places like China and Japan.

“In Asia they pay a different price for gas,” Mr. Mortlock says.

“As their economies continue to grow, they need to diversify where they get their gas. If you are reliant on the Middle East, or Iran or Russia to get your gas — that’s not necessarily reliable. So if you can get your gas from a stable country like Canada, that’s a big factor.”

Where should investors look for exposure to shale gas if it turns out demand ramps up natural gas prices?

John Dunn, upstream analyst at Wood Mackenzie, has highlighted Alberta’s Duvernay shale deposit as a key area of interest.

“We believe that the rich-gas window will generate the strongest returns and be the focus of future activity, due to both high initial production rates and strong Canadian condensate prices,” he writes in a research note.

For investors looking for companies with interests in the still-developing Duvernay, they’ll have to look to some of the biggest — Encana and Talisman Energy (which recently announced it wouldn’t pursue shale interests in Quebec), Yoho Resources and Athabasca Oil Corp.

However, Mr. Mortlock says in the case of shale gas, bigger is better and the major gas companies are the ones that will likely prosper in the decades to come.

“In a challenging market, bigger companies have the ability to continue to make investments when the market is down at potentially cheaper prices if they take a long-term view,” he says. “The super majors have a strong balance sheet and can take a longer perspective. Junior companies are sometimes making day-to-day decisions.”